Battle of Fed Presidents - Kocherlakota vs. Lockhart

Kocherlakota, President of the Federal Reserve Bank of Minneapolis:

"The job market is, finally, on a highly desirable upward trajectory," he said. "We are more likely to continue on that welcome trajectory if the (Federal Open Market Committee) does not tighten monetary policy in 2015."

Contrast that to the more optimistic, but slightly more hawkish stance of Dennis Lockhart, President of the Federal Reserve Bank of Atlanta.

“The risk manager in me will lean to preferring a later date for the first policy move to an earlier one,” 

“I supported and expect to continue to support a patient approach, one that is relatively cautious and conservative as regards the pace of normalization of rates.”

“As I look back on 2014 and look ahead to 2015, I can comfortably assert that, more, the U.S. economy is hitting on all cylinders,” 

“The momentum evident in the second half of 2014 will carry over into 2015, and the ongoing outlook will remain solid,” Lockhart said. 

“If that is indeed the case, I believe the first action to raise interest rates will in all likelihood be justified by the middle of the year.”

“I expect continued robust job creation accompanied by growing wages,” he said. “And, while acknowledging some room for skepticism about the inflation picture, I’m looking for inflation to rise gradually through year-end.”

Even if his forecasts are right, why would the Fed have to raise rates in such circumstances? 

Imagine a scenario where core CPI remained slightly above the Fed's inflation target for a few months while unemployment was falling rapidly where nominal median wage gains was actually rising faster than the inflation rate plus the productivity growth rate.  In other words, in this scenario economic activity is picking up markedly allowing for labor markets to become tight enough where labor's share of income was actually rising after decades of decline. 

Would you vote to raise the policy rate?  What if core CPI read 2.5?  3.5?  4? 

If you were to decide to tighten policy, what is your goal in doing so?  Slow the pace of the recovery?  Reduce the tightness in the labor market by reducing the pace of the labor rebound?  Reverse the gains in labor's share of income (which is the inverse of...)? 

As important as mandates are in setting goals for the Fed, I think they're dangerous because it allows members of the FOMC to use these targets to justify their decisions when shifting the policy stance in a way that will create winners and losers without explicitly identifying who they are.  Moreover, why is 2.5% the Fed's short term inflation target?  What would happen if it were 3? 4?  Again, who would win and lose from this shift?  I ask because it feels like 2.5% is this hard short term upper limit where if inflation* stays above it danger will break loose.  However, if inflation were to remain below it month after month as it has then everything is fine.  The policy feels not only a bit arbitrary, but definitely asymmetric. 

I certainly don't think that monetary policy should be the only macrostabilization tool.  I'm still wondering how effective it can be relative to the costs when the policy rate hits the ZLB.  However, I think it can be very effective when pushing in the other direction.  It can be a force to slow a recovery in a domestic economy where households are highly leveraged. 

My grip is with how members of the Fed communicate their goals and why.  Not so much Janet Yellen since I think she has been very good.  It's the hawkish stance where sometimes I feel that it's nonsensical or inappropriate for today's situation.  It very well may be the correct stance under some other circumstances, but today I still find that very hard to believe even if US economic activity were about to accelerate.  Good, let it!  Why even attempt to slow it down?

*I also want to clarify that I don't see inflation as an economic good in itself.  Under circumstances where demand is deficient, where there is a mismatch between between desired savings and investment opportunities resulting in low levels of interest rates, inflation, and output gaps, it's more likely that the monetary and fiscal policy mix is and has been overly tight.  A more expansionary policy mix should be instituted if it means more robust demand, economic activity, business investment, and rapidly rising wage growth even if this "risks" rising inflation in a lowflation environment.  With the output gap still large, where the economy's productive capacity is still yet to reach it's limits, inflation briefly above 2.5% should certainly not be a reason to slow down any recovery.  This makes it even more inappropriate for the Fed to tighten when they have failed to hit their dual mandate for 3 years especially as market inflation expectations have declined over the last few months!  Ever heard of catch up growth?  

This is why a Nominal GDP or price level target are both superior forms of monetary policy.  It requires that catch up growth occur, where the current policy framework doesn't.